mREITs - Which Companies Had The Best Swaps For Q2

by: Dividend Living

Mortgage REIT earnings reports for Q2 have started to come in. CYS Investment (NYSE:CYS) and Hatteras Financial (NYSE:HTS) have reported large book value drops.

Stock % drop in book value Q1 book value Q2 book value
CYS 20.7% $12.87 $10.20
HTS 21.3% $28.12 $22.12
Capstead (NYSE:CMO) 5.8% $13.60 $12.80

Recently I compared mREITs by how much their portfolio was weighted into below 4% coupon agency 30 year fixed Mortgage Backed Securities (MBS). Although all agency MBS lost value in Q2, below 4% coupon 30 year fixed lost the most value. (Data from Mortgage News Daily)

MBS Value change 3/31 - 6/31
30 year fixed 3.0 coupon FNMA -6.59 -6.3%
30 year fixed 3.5 coupon FNMA -4.78 -4.5%
30 year fixed 4.0 coupon FNMA -2.88 -2.7%
30 year fixed 4.5 coupon FNMA -2.28 -2.1%
15 year fixed 2.5 coupon FNMA -4.19 -4.0%
15 year fixed 3.0 coupon FNMA -2.75 -2.6%
15 year fixed 3.5 coupon FNMA -2.00 -1.9%
15 year fixed 4.0 coupon FNMA -1.63 -1.5%

mREITs hedge with swaps and other instruments. These hedges are set up in part to preserve book value when rates rise. The best performing swaps in Q2 had a 5 year duration or longer. (Data from the Federal Reserve)

Swap Duration Q1 end rate Q2 end rate Change
1 year .36% .38% +.02%
2 year .42% .55% +.13%
3 year


.87% +.33%
4 year .73% 1.26% +.53%
5 year .97% 1.64% +.67%
7 year 1.46% 2.22% +.76%
10 year 2.03% 2.77% +.74%

HTS provided a graphical depiction of the above tables which included adjustable rate mortgage securities values.

(Click to enlarge)

Below is a chart comparing the percent of total holdings that are below 4.0% coupon agency 30 year fixed MBS to the % of agency holdings (not just low coupon fixed, but all agency holdings, including adjustable rate mortgages) covered by 5 year duration swaps or longer. This chart gives an incomplete, but useful picture of how the hedges may have performed in Q2. It shows the % holdings of the worst performing MBS and the % of agency assets covered by the best performing swap hedges.

Stock % holdings < 4% coupon Agency 30 year fixed MBS % Agency MBS covered by 5 year duration swaps or longer
Javelin (NYSE:JMI) 92% 46.6%
Western Asset (NYSE:WMC) 49.5% 40.7%
ARMOUR (NYSE:ARR) 69.3% 35.4%
American Capital Agency (NASDAQ:AGNC) 39.7% 16.0%
AG Mortgage (NYSE:MITT) 35.5% 34.1%
American Capital Mortgage Investment (NASDAQ:MTGE)


Apollo (NYSE:AMTG) 38.1% 15.8%
Invesco (NYSE:IVR) 0% (no breakdown, average is 4.0% coupon) 6.7%
New York Mortgage Trust (NASDAQ:NYMT) 0% 0%
CYS 45.5% 8.7%
Ellington Financial (NYSE:EFC) 0% (no breakdown, average is 4.02% coupon) 11.0%
Arlington Asset (NYSE:AI) 0% 0% (uses eurodollar futures to hedge almost exclusively)
Annaly (NYSE:NLY) 73.4% 12.8%
Two Harbors (NYSE:TWO) 25.5% 23.1%
Dynex (NYSE:DX) 0% 10.4%
HTS 0% 0%
Anworth (NYSE:ANH) 0% 0% (average maturity 3.2 years)
MFA (NYSE:MFA) 0% 0%
CMO 0% 0%
Zais (NYSE:ZFC) 39.3% 77.5%

Swaps are not the only part of an effective hedge. Hedges may also include swaptions, euro dollar futures, interest rate caps, short positions in treasuries, non-agency MBS, TBA's, or other holdings (such as CMBS). mREITs could have sold lower coupon MBS during the quarter, bought more swaps and other hedging instruments, or otherwise re-arranged their holdings to reposition for a QE3 taper and to preserve book value. For a more complete picture of Q2 performance before earnings, an analysis similar to REIT Analyst's articles on AGNC, CMO, HTS would be in order.

From a look at the above numbers, WMC, MITT, EFC, TWO, and ZFC are poised to announce a book value preservation that will be better than their peers (DX has too much exposure to the adjustable rate mortgages that have lost a surprising amount of value in Q2 to be included in this list). Below is a current look at price to book value.

Stock P/BV
WMC .848
MITT .771
EFC .931
TWO .892
ZFC .809

Before starting a position in these stocks, I would advise a more thorough look at holdings and hedging positions that can be accessed through the investor relations page of each stock. Links to those pages are included in my Comparing Mortgage REITs article.

Disclosure: I am long (TWO), (MTGE), (WMC), (AMTG). I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I am long MORL, which has a stake in all of these stocks except ZFC, JMI, WMC, AI, NYMT, AMTG and EFC.